Pagaya Technologies Ltd. (PGY) Q4 2023 Earnings Report, Transcript and Summary

Greetings, and welcome to Pagaya Q4 2023 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jency John. Thank you. You may begin.

Thank you, and welcome to Pagaya's fourth quarter and full-year 2023 earnings conference call. Joining me today to talk about our business and results are Gal Krubiner, Chief Executive Officer of Pagaya; Sanjiv Das, President; and Evangelos Perros, Chief Financial Officer. You can find the materials that accompany our prepared remarks and a replay of today's webcast on the Investor Relations section of our website at investor.pagaya.com. Our remarks today will include forward-looking statements that are based on our current expectations and forecasts and involve certain risks and uncertainties. These statements include but are not limited to, our competitive advantages and strategies, macroeconomic conditions and outlook, future products and services, and future business and financial performance, including our financial outlook for the first quarter and full-year 2024. Our actual results may differ from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are described in today's press release and fillings, and in our Form 20-F filed on April 20, 2023, with the U.S. Securities and Exchange Commission, as well as our subsequent filings made with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. Additionally, non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, adjusted net income, fee revenue less production costs, or FRLPC, FRLPC margin and core operating expenses will be discussed on the call. Reconciliations to the most directly comparable GAAP financial measures are available, to the extent available without unreasonable efforts, in our earnings release and other materials, which are posted on our Investor Relations website. We encourage you to review the shareholder letter, which was furnished with the SEC on Form 6-K today for detailed commentary on our business and performance in conjunction with our company earnings supplement and press release. With that, let me turn the call over to Gal.

Thanks, Jensy. Before I begin, I'm pleased to note that joining me today on our call is Evangelos Perros, or EP, our newly announced permanent CFO; and Sanjiv Das, who joined us a few months ago as our President. These two leaders have decades of experience in financial services and consumer lending between them. EP previously had senior roles in Finance and Investment Banking at JPMorgan Chase and most recently was a Managing Director and Head of Business Planning and Analytics at Apollo. He started at Pagaya about two years ago and has been instrumental in taking our company to a new level of profitability and disciplined financial execution. Sanjiv brings with him deep experience in consumer lending and capital markets, having served as the CEO of CP Mortgage Division and in senior roles at Morgan Stanley, American Express and Bank of America, and most recently, the CEO of Caliper Home Loans. They will share today their perspectives on the opportunities ahead of Pagaya, which will inform their respective priorities in 2024 and beyond. I'm proud of the talent we have brought into this organization and I'm confident that these two leaders will take our company to the next level. Moving on to discuss our results in 2023. 2023 was a record year in Pagaya's history. We far exceeded the target we set at the start of the year, with full year network volume of $8.3 billion, total revenue of $812 million and adjusted EBITDA of $82 million. We are delivering sustainable profitability with an improvement in adjusted EBITDA now for four quarters in a row, reaching an annualized run rate of over $135 million based on the fourth quarter. Network volume grew 33% in Q4, also growing from the past four consecutive quarters. We increased monetization of our lending network with our personal loan vertical now generating an average FRLPC of 5.5% and some of our top partners generating FRLPC above 6%. We reported our second consecutive quarter of positive GAAP operating income and positive cash flow from operations. The integration of our 2023 cohort of lending partners is progressing well. Our product with U.S. bank is already delivering a 2x activation rate, compared to our personal loan product average. In auto, expansion with three leading national auto lenders, gives us access to thousands of new dealerships across the U.S. and in SFR, Darwin, our tech-enabled property management platform is now catering to some of the country's largest institutional clients and we are on-track to managing 13,000 homes on the platform by the first half of 2024. Our prefunded model enabled us to effectively optimize for growth throughout 2023. We solidified our leadership as the number one personal loan ABS issuer in the country, issuing $6.6 billion across 15 deals and growing our investor branch by 31 new firms. We continue the momentum with the addition of 11 new investors in just January this year, reflecting continued strong demand for our financial products. By achieving a step change in our network in 2023, we believe 2024 will be a year of momentum. We aim to accelerate our growth as a product and partner centric company. Since our inception in 2016, our vision was to use technology to enable the financial services industry to provide more American customers with access to credit. After scaling our flagship product, our second stage reevaluation program, we developed an enterprise grade lending product that could meet the needs of the largest financial institutions in the country. This led to the onboarding of lenders like Ally Financial, Klarna, U.S. Bank, Westlake, a top five auto captive and Exeter. Our integration with larger scale lenders is helping us to understand how to be the true partner in achieving those growth objectives. The raise of integration with each of our partners can be utilized cross-sell more product, expanding to new verticles and driving the reach into new customer segments. This will form the basis of our 2024 product and partner strategy, paving the path for Pagaya to become the trusted lending technology partner for the country's largest financial institutions, as we march towards becoming a $25 billion network volume company. Our 2024 strategy consists of three key elements: Number one, expanding our product to new enterprise lenders. Number two, deepening existing partnerships and enhancing network monetization. And number three, building out the road map to expand our product ecosystem. First, we plan to expand our product to new large scale enterprise lenders across markets. Last week, in collaboration with U.S. Bank, we announced our exciting new partnership in our personal loan vertical. With a top five bank, we now have four enterprise level lenders, including Ally Financial, SoFi and a top five auto captive in our lending technology ecosystem. That means, our flagship product not only meets the advanced technology needs of large lenders, but the rigid regulatory and compliance standouts of the U.S. consumer banks. Our recent conversations with other marquee lenders, both in and outside of our current pipeline, gives me confidence that our flagship product is in high demand and we will be able to add more banks, auto captive and other large U.S. lenders to our network in this near term. The addition of each enterprise lender means connecting to millions of new customers, the opportunity to extend across multiple products and tens of millions of dollars to our bottom-line once fully wrapped. Second, we will aim to deepen existing partnerships and enhance network monetization. By accelerating volume growth with our newer partners, we believe we can bring economics more in line with our mature partner, who are currently earning FRLPC above 5%. EP will speak more to this in a moment. Third, and what excites me the most about Pagaya's future is that, we will build more products for the lenders in our ecosystem. Banks are in a race to transform the customer experience as well as their internal systems with technology. Our experience partnering with the country's leading fintechs over the last few years means that we are uniquely positioned to help banks connect with their customers through online channels, bringing them one step closer to their customers. Example of products that are in high demand for banks are point-of-sale solutions and online prequalification marketing products that are delivered in app, and rewards to partner existing customers with additional credit opportunities on a push basis. These examples are just scratching the surface of what our technology, product infrastructure and funding capabilities can achieve. As we expand our product ecosystem, Pagaya is well-positioned to become the country's go-to lending technology partner. The success of our 2024 growth plan will rely on the disciplined and balanced approach to volume growth, profitability and capital allocation as we aim to move from delivering positive cash flow from operating activities to total net cash flow positive by early 2025. EP will discuss in more details in a few moments. To close, I believe Pagaya is in a strong position to transform the consumer finance ecosystem at scale. Our differentiated product and efficient funding strategy has positioned us to lend transformational lending partners and deliver record financial performance. We expect to capitalize on this momentum as we execute in 2024. With that, let me pass it over to Sanjiv to discuss his views on the company's evolutions from here.

Thank you, Gal. I want to start by sharing why I chose to come to Pagaya. I joined because of its unique value proposition in the network between consumer lenders and capital providers who seek exposure in this asset class. I believe the decision Pagaya has made over the past two years to focus on banks as partners and in scaling and diversifying its funding base were absolutely the right ones. Banks need Pagaya's products more than ever. The current interest rate environment and regulatory conditions have resulted in a broader trend in the tightening of credit. While at the same time, there is significant amounts of private capital waiting to be deployed into quality consumer assets, specifically those underwritten by high-quality, data-driven AI models. These trends create a unique opportunity to capture the full value we can provide to lenders, by partnering with them through products that are complementary and deeply integrated in their lending ecosystem. Building this institutionalized capability will be our focus in 2024. We are now developing a clear product roadmap, as we expect to expand our footprint to new lenders and deepen our current relationships, while creating new monetization opportunities for Pagaya. We are exploring more capital-efficient products that can enhance our firepower as we ramp-up network volume from recent partnerships. We will continue to optimize capital allocation in a very disciplined way, as we strengthen our funding network while prioritizing financial flexibility and risk management. Critical to our success in the long-term is an organization that is laser-focused on disciplined execution to achieve our mission. The organization that we initially built, laid the foundation to deliver a single product to lenders. We are now evolving to become a multi-product enterprise. Our execution will be governed by a strong focus on enhancing margins and capital efficiency as we grow. We are only at the beginning of a continued evolution and I'm excited for what the future holds. Thank you for your time today. I will now pass it to our CFO, EP, to discuss our financial results in more detail.

Thank you, Sanjiv. I'm honored to join all of you today on my first earnings call as CFO of Pagaya. I'm looking forward to working with our leadership team as we execute on our vision and building long-term partnerships with all of you in our investment community. As Gal mentioned, we believe our business is well-positioned to execute in 2024 in light of the macro backdrop. Over the past two years, we have made significant strides to become a profitable growth company. We grew prudently in a tough market environment, prioritizing unit economics, cost efficiency and disciplined capital allocation and risk management. In 2023, we delivered record network volume, total revenue and adjusted EBITDA, exiting the year with positive quarterly cash flow from operating activities, operating income and adjusted net income. We expect to build on this momentum in 2024 with a focus on progressing the next two financial milestones of our company. One, positive total cash flow generation by early 2025. And two, paving the way to GAAP net income profitability. We are taking action to deepen the monetization of our network, while scaling in an efficient way to drive operating leverage. We will continue to execute a disciplined capital allocation strategy, focused on balancing profitable growth and financial flexibility. With these actions, we expect to continue to successfully navigate the evolving macro environment to deliver our plan for 2024. Additionally, we are committed to increasing transparency with our shareholders and taking action to increase stock marketability and drive shareholder value creation. As we announced, we will be electing to file on U.S. domestic issuer forms beginning with our Q1 results in May. Moreover, we expect to effect a reverse stock split within the first two weeks of March with a final ratio of 1 for 12. I encourage you to read our shareholder letter and earnings supplement materials, which contain details on our financial performance. Turning to our fourth quarter results. We achieved record network volume of $2.4 billion in the quarter, up 33% year-over-year with growth primarily driven by the ramp-up of new partnerships in point-of-sale and single-family rental. Total application flow was $183 billion in the fourth quarter, up 7% year-over-year. Our average conversion ratio was 0.8% in the quarter, as we continue to optimize for investor returns in the higher rate environment. Total revenue grew 13% to a record $218 million in 4Q 2023, compared to the same quarter in 2022, driven by an 18% increase in fee revenue, which represented 97% of total revenue. Interest and investment income declined year-over-year due to the shift in timing of interest income accruals related to a change in our ABS structures. Fee revenues less production cost, or FRLPC, grew by 42% in Q4 to a record $76 million. Fees from our lending product amounted to 63% of total FRLPC compared to 32% in the same quarter in 2022, more than offsetting the 19% decline in capital markets execution fees. This is a testament to the recurring and sustainable earnings power of our fee generating business. FRLPC margin increased 20 basis points year-over-year to 3.2% in the fourth quarter, within our target range of 3% to 4%. We see meaningful opportunity for further improvement. Our personal loan business, our most mature vertical, generated an FRLPC margin of 5.5% with some of our top partners delivering margins above 6%. Our auto vertical continues to be below the blended average with an FRLPC margin of 3%. Additionally, our SFR vertical, which remains immaterial to our overall financial results was dilutive to our FRLPC percent margin in the quarter, due to the integration of a larger number of homes to Darwin platform. While our FRLPC market may continue to be impacted by the onboarding of new partners and growth of less mature verticals, we have a very clear playbook to elevate economics over time. Higher FRLPC is translating directly to our bottom-line with the benefit of the operating leverage inherent in our business. In the fourth quarter, we delivered record adjusted EBITDA of $34 million, with an adjusted EBITDA margin of 16%. This is our second consecutive quarter of positive GAAP operating income, which was $11 million in the quarter. Our core operating expenses, which excludes stock-based compensation, depreciation and one-time expenses, declined by 19% year-over-year to $51 million. Share-based compensation expense of $14 million declined by $5 million, primarily driven by lower headcount and the timing of vesting of equity awards. Net loss attributable to Pagaya was $14 million in the fourth quarter, an improvement of $20 million from the prior year, primarily due to our strong operating results. Other income amounted to negative $26 million, primarily impacted by a fair value adjustment on investments in loans and security. After accounting for non-controlling interest and net fair value adjustment attributable to Pagaya was negative $13 million. Interest expense of $11 million in the fourth quarter was primarily related to our secured borrowing, which are used to finance our risk retention requirements, reflecting the higher rate environment and the change in composition of the underlying collateral. We reported our third consecutive quarter of positive adjusted net income of $12 million, which excludes share-based compensation and other non-cash items such as fair value adjustments, an improvement of $16 million compared to the prior year. We reported our second consecutive quarter of positive cash flow from operating activities of $19 million with full year operating cash flow of $10 million. We believe this is an important milestone towards achieving total net cash flow generation as we scale. Shifting now to discuss our approach to capital allocation and risk management. We operate our business to optimize growth, profitability and liquidity. Our ability to deliver growth in this environment is supported by our unique funding model. By raising capital before assets are originated compared to traditional funding models, we are able to avoid warehousing assets that require months of seasoning, allowing us to generate over $8 billion in network volume last year without significant use of our balance sheet. This flexibility means we have multiple levers at our disposal with the way we allocate capital to support the growth of the fee generating side of our business. We also view this as an effective strategy to attract new investors to our network and strengthen our long-term funding capabilities. This is demonstrated by the 31 new institutional investors we added to the network in 2023 and the $6.6 billion in new funding raised across 15 ABS transactions. And in 2024, we are beginning to see signs of improving demand and risk appetite from investors, which we anticipate will translate to lower corporate risk participation in our deals. The scale and reputation we have achieved combined with stabilizing asset performance in 2023, have become a key differentiator in our ability to explore new capital efficient structuring alternatives. Our net holdings in investment in loans and securities after accounting for non-controlling interest amounted to $611 million as of December 31, reflecting risk retention holdings for deals completed between 2019 and 2023. To put this in context, this reflects a ratio of approximately 3% of over $20 billion in total funding raised over this time. Net of non-controlling interest, the total fair value impact to our net holdings was negative $16 million, of which $13 million impacted other income and $4 million impacted other comprehensive income and loss in shareholders equity. I'm very pleased with the recent step change we achieved with the announcement of our $280 million credit facility in February, which was subsequently upsized to $290 million. The transaction was led by BlackRock and partnership with UBS and in syndicate of our relationship banks, including JP Morgan Chase. We believe this transaction represents a strong vote of confidence from leading financial institution following months of extensive due diligence on the company's financial strength and future cash flow generating power. After repaying outstanding borrowings under our existing credit facility, the incremental liquidity will help us invest in product development and network expansion. Moreover, from a risk management perspective, it eliminates refinancing risk by extending our corporate debt maturity from 2025 to 2029. With these achievements, we are well-positioned to deliver our 2024 financial plan, which we believe will get us closer to our goal of achieving positive total net cash flow by early 2025 and pave the path to future GAAP net income profitability. First, we are focused on deepening the monetization of our lending product to drive FRLPC growth. We have demonstrated our ability to increase monetization of our most mature lending channels. We are in discussions or have already executed improved fee sharing agreements with other lending partners, which we expect to have a positive impact on FRLPC later this year. Second, we'll continue to focus on prudently managing our expenses to drive more flow through of FRLPC growth to the bottom line. This year, we expect to realize a full year benefit from cost savings initiatives implemented throughout 2023 and we expect to fund 2024 investments without meaningfully increasing our core operating expense base. Our goal is to reach total net cash flow positive by early 2025, assuming no material change in the macroeconomic conditions from what we see today. First, as we scale our network with deeper monetization and the benefit of operating leverage, we expect continued growth in cash flow from operating activities. We also expect to minimize the combined net cash outflow from investing and financing activities, by shifting to more efficient funding and capital structures, supported by our recent strong funding execution and stabilizing asset performance. Now let me switch to our 2024 financial outlook. Our guidance reflects a few key assumptions. In terms of network volume, we expect to remain prudent with our conversion rate of application volume, while optimizing network volume to our more mature and profitable lending channels. Network volume contributions from our 2023 partner cohort are expected to more meaningfully materialize in the second half of 2024, and we expect minimal contribution from any new partnerships onboarded within the year. Finally, we expect continued growth of our single-family rental vertical as a result of new partnerships with our Darwin platform. We expect growth in total revenue and other income and FRLPC as we continue to deepen monetization of our lending product, which we expect to continue to offset lower capital market execution fees. Combined with disciplined cost management to improve operating efficiency, we expect continued growth in adjusted EBITDA. In the first quarter of 2024, we expect network volume to range between $2.2 billion and $2.4 billion, total revenue and other income to range between $225 million and $240 million and adjusted EBITDA to range between $32 million and $38 million. In full-year 2024, we expect network volume to range between $9 billion and $10.5 billion, total revenue and other income to range between $925 million and $1.05 billion and adjusted EBITDA to range between $150 million and $190 million. With that, let me reiterate how excited I am to be partnering with you on our journey, and let me turn it back to the operator for Q&A.

Thank you. [Operator Instructions] The first question we have is from Joseph Vafi of Canaccord Genuity. Please go ahead.

Hey, everyone. Good morning. Nice results and congrats on the new roles, both to Sanjiv and to EP. Just maybe just a few on some of the operating metrics looking at 2024, on the investor side, on the execution fees and then also on conversion rate. I mean, obviously, Fed funds rate's probably one of the key things for us to be looking at there in terms of potentially higher conversion rate and execution fees. Is there anything else we should be looking at relative to providing upside on those metrics? And then I have a quick follow-up.

Hi Joe, it's Gal here. Thank you so much for your question. Great to see you. So let me start with the second piece. As we think about where we are standing today, obviously, the 2024 is a much more constructive year, as I will put it this way. When you think about capital markets and the very strong performance that we had in 2023, both on the assets and the ability to actually raise the capital, we have a strong momentum as we go to 2024, as you know, one of the biggest, the biggest personal loan um, issuer in ABS this year. So when we think about 2024, we are taking into our plan still the concept of being very prudent and we are managing and guiding the street to what we think is doable given everything stay the way it is. Now, to your point, the Fed might be and its peak of their cycle, and therefore, there is potential ways to be more constructive even and better outcomes as we think about the 2024. It just that by the way we think about it, we need to see that actually transforming into a real outcome, over a few quarters and therefore reactive to that. So to the bottom of your question, the 2024 plan is subject to, we believe that the environment is going to stay as it is right now, which is better than 2023. And as we think about the future and how different macroeconomical trends will play, if to the positive, will definitely allow us to have some more room to play there.

Great. Thanks for that, Gal. And then, maybe just one for Sanjiv, again, congrats on the new role. Are there a few things that you think that you're going to be focusing on here in 2024 relative to, you know, I mean, you've seen a lot, I think so far. Are there a couple things that really stand out for you as opportunities and things for you're going to focus on here this year? Thanks a lot, guys.

Sure. Thank you for the question, Joe, and thank you for the wishes. I'm excited to be here. As you know, Joe and I sort of mentioned this before, as a former CEO of Citi's largest business, Citi's Mortgage Business had very troubled times. And sort of turning that around, I have come to Pagaya with tons of consumer banking experience and sort of know this space extremely well. And so when I stepped into Pagaya and met our clients and partners, including several of the major banks, and when I talk to the CEOs of, let's say, U.S. Bank's consumer business or Citi's consumer business, many of whom are former trusted colleagues, who have sort of seen how we have built things in a highly regulatory compliant way. I'm actually very pleased to see what we've seen in Pagaya's execution in terms of building a very regulatory robust product and it actually meets the need for banks in a very strategic way. And so, the more I understand Pagaya's second stage fee evaluation product, which is sort of what I inherited, I'm really pleased to see that how well integrated it is into the bank's ecosystem and the consumer ecosystem. Frankly, if I were back to my previous job as CEO of Citi's Mortgage Business, I would sign up for Pagaya solution instantaneously. I know we call those things non-QM and stuff like that, but those are done in such a seamless way that I'm really enthused about it. In summary, I feel like the foundation of what we've laid out so far is really good and it allows us to now focus on multiple products and deepening into the ecosystem of the franchises that we already deep into. So super excited about that.

The next question we have is from Michael Legg of The Benchmark Group Company. Please go ahead.

Thanks. Congratulations on a great quarter, guys. Two questions. One, can you just talk about your viewpoint on the consumer debt burden as we see debt increase per consumer and how that impacts the longer-term model? And then second, you mentioned that 10 to 15 cost lending partners in the pipeline with the 12 to 15 month lead time on some of them. The U.S. Bank, when you sign them up, obviously that was a longer lead time. Can we read anything into the size of these new partners based upon the lead time you mentioned? Thanks.

Hi, Mike. Definitely. Let me start with the first one. I think from a consumer health perspective, if I would need to characterize 2023, I will call it a year of stability. I think too many ways, two major phenomena have happened. On the one hand side, different banks and lenders has become more scrutiny on the ability to provide credit and therefore credit availability went down. On the other side, as we’re now looking back on 2023, it is obvious for us because of our unique network data advantage, it was obvious even in 2023. But the consumer is in a steady place. The big rush of like the inflation that happened in '21 and '22, which drove underperforming vintages for the consumer credit in general is starting to stabilize, especially in the areas where we are focused on, which is the side prime, near prime, whatever you want to call it. As we think about the future and given that there is now a trajectory of how we are going to balance in between the reduction of the interest rate while still having a strong economy, while we are prudent and cautious, we do see the consumer behaving more or less as we expect. So that to that level. And I think that if you think about it from a future perspective, we expect 2024 to be a year where we are transforming the stability into momentum. Because usually what happens is when investors and capital markets is kind of like seeing the stability is coming through, it allow you to have better execution, better outcome, and quite frankly, cheaper cost of capital on the full capital stack. So that's how all of that is related to us as a business. Now, to your second question, which relates to how you think about the onboarding of the new partners, especially on the enterprise grade level. So I want to give you my own personal perspective of that. As you know, I'm one of the founders of Pagaya and started here in 2016. And every one or two years, we have like a major jump that make Pagaya a different organization and different company. The first one was the first flagship product that we had after that was tapping into the capital markets in major deals. After that were the first auto lenders that we onboarded and kind of like having our product modified to the second piece. When I think about all of them, getting integrated to an enterprise-level banks, such as U.S. Bank that this quarter has become public, is potentially the biggest milestone change that we have did so far. It open up a variety of positive momentums for Pagaya, which I want to lay out here for you to appreciate these pieces. So the first one is when there is a top five bank that is, as you can imagine, very heavily regulated, putting their name out there and saying, this is helping our customers and we did all the checks and balances in order to make it as our product, it gives a lot of confidence for other banks to follow. So to your question about the deep 15 funnel, it's not something that we say that there are 15 active that are going to 18 months, be translate into 15 clients, but it's 15 names that we know that if played well and subject to our two to four players a year, going to be definitely the next wave of banks or enterprise-level grade that are coming into our network. Now why is that so important? Because now it's starting to become as more rinse and repeat. We have cracked the code, we have perfect the product, and now it's really about having the right conversation. And as you heard from Sanjiv, our leadership team is very well connected into this industry and will be able to make it happen. So we are not obsessed about time. It doesn't matter for us if it happens in 6, 12 or 18 months. What matters to us it's happened rightfully and in the right scale and that's what we are driving towards. The last point I will add before we close that question is think about the opportunities and the unique value proposition and the additional product, again, as Sanjeev mentioned, that one could drive with big partners like U.S. Banks and others. We see that happening in action and we are getting more requests of more technology business that they would like us to do with them. It's opened up not just deepening the current flagship product that we have, which is the reevaluation second stage product, but it's opening for us the ability to think about more products down the road for them. Marketing products such as pre-qualifications, in-app offers, and so many more ways to serve their customers to the standard that they would like to have. From that perspective, you can think about Pagaya, we are trying to become the technology lending partner for the biggest institutional clients in the U.S. and I think that funnel is representing a lot of it.

The next question we have is from David Scharf of Citizens JMP. Please go ahead.

Hi, good morning, and thanks for taking my questions, and welcome aboard as well to EP and Sanjiv. Maybe two questions, maybe on each side of the marketplace. The first just focusing on the economic model on the demand side, specifically the product side. I don't want to get too far ahead. I know you just rolled out 2024 guide. But just given the relative size of some of the markets, specifically auto is so much larger than personal loan, still remains to be seen kind of how point-of-sale evolves. As you think about the product mix going out in a few years, does that change the target margin, the FRLPC margin? I mean, clearly, the personal loans have the highest take rate of 5.5% right now. But just wondering how we should think about the product mix and whether that impacts the margin structure going forward?

Thank you, David. It's a great question. The way to think about it is, obviously, every vertical in our products is somewhat unique in terms of its unit economics. But the way to think about it is within its vertical, we have mature partners and sort of less mature partners, right? And it takes about, call it, 6 to 12 months to ramp up some of the newer partners that are get added to the network. And the more mature partners obviously enjoy a higher FRLPC margin. We have a very clear playbook on how to take the newer partners and elevate them to the same economics as the more mature partners. As you think about the future in 2024 and beyond, there is always going to be a mix between that dynamic of mature partners, where we're earning higher FRLPC margin and the newer partners that are coming in and get elevated over time. Auto is obviously an area that is growing very fast. Today, they're at approximately 3% FRLPC margin. As we continue to invest into that vertical, we expect obviously more volume coming in from the newer partners, while we continue to elevate their economics over time. That's how to think about the mix. Ultimately, when you take that all to the bottom-line, this is what drives our overall guidance of approximately 3% to 4% FRLPC margin at any point in time.

Got it. That's helpful. It sounds like, as auto scales and matures, we'll see margin expansion just like we have over time with personal loan. Great. Maybe just a follow-up on the funding side. Can you maybe provide some guideposts, you know, as we think about network volume growth and just the pace at which you're underwriting. Maybe what level of risk retention we should be thinking about for year-end ‘24, you know, up from the 611, and maybe put that into context with kind of your credit facility and borrowing capacity?

Sure. And you might have seen our, shareholder later, right? I'll go back into our, one of our key milestones, which is to plan to get to a positive total cash flow by early 2025. We're in a very strong position today to support our plan for profitable growth and that is very heavily supported by our access to alternative source of capital and other funding alternatives, which is evident by the recent term loan and our very strong funding execution in 2023. And obviously, in 2023, we had to -- we chose to lean in more in line of the current market environment. But when you take all of this into considerations and given the signs of improvement that we see for 2024, even with sort of the risk participation requirements, we expect to get to cash flow positive by early 2025.

The next question we have is from John Hecht of Jefferies. Please go ahead.

Yeah, good morning. Congratulations on a great quarter. Sanjiv and EP, look forward to working with you guys and congratulations. I guess dovetailing a little bit on David's last question. You talked, you guys mentioned more optimal funding in ‘24. You also talked about, you know, the evolution of a lot more private credit interest in this type of asset class. I'm wondering, for ‘24, are there other options to think about in terms of capital markets executions outside of a standard ABS, maybe like a flow agreement or something? And is that something you guys would be considering at this point in time as you think about funding through ‘24?

Yes. John, it's Gal here. Thank you. Thank you for joining us. I think it's your first earnings call, so exciting. Yes. So that's exactly right. When we are thinking about the 2024, and with the dry powder we have and the financial stability and the BlackRock credit facility or the term loan, and as we think about the production that we need to originate and fund, as we think about the yield on the back of the very strong performance that we have in 2023, we do see more private credit coming in and taking the ability to have full stack risked off and other places where you can actually partner up and provide the ability to have diversification of different funding, which is not just like on the pure ABS as we know it today. So when we think about that and the plan, we are in the belief that that's going to be a path that we are going to grow through 2024. And we are already in a different discussions, about these things and we think it's going to materialize, as we think about the yield coming along.

Okay, that's helpful. Thanks. And second question. You know, I think the last several quarters you've had, you know, more optimal and more efficient OpEx, I think it's down on a dollar basis each quarter, last year. How do we think about that through this year? Are you at a point where you kind of optimize that and it should be more flattish going forward? Or do you need to add to that given the growth anticipation? Just wondering from a modeling perspective.

Sure. Thank you for the question. You're right. If you look back in late 2022, we had more elevated operating expense base as a result of our continued investment back in the day to support our public company readiness and investment in other areas. We have taken action over the course of the last few quarters to bring the expense base to a more rationalized level and we feel the current expense base is at the right level to support our 2024 plan and beyond. We can always obviously be have places where we can put a little bit more improvement and investment into it, that can be supported by additional savings in which we reflect in our 2024 plan.

The next question we have is from Hal Goetsch of B. Riley Securities. Please go ahead.

Good morning, everyone, and thanks for the call. My question is on the application flow and the conversion rate. In fourth quarter and most of 2023, the conversion rate tailed off to less than 1% and then materially higher maybe in 2021, but you might say that, wasn't a normalized period. Could you just discuss some of the swing factors in the current environment that are keeping it pinned at this level? What is the art of the possible for this to move from sub 1 to 1 or 1.1 or 1. 2, something modest that would have a material change in volume on a similar application flow? Can you discuss that for us please? Thanks.

Sure. Thank you for the question. What I would say, obviously, we try to optimize for growth, profitability and liquidity. And as we keep on adding new partners to our network, application flow is expected to increase and it has year-over-year, about 7%. Given the current environment as we're optimizing, as I said, for liquidity and also investment returns, we are being prudent about our convention ratio. As we look on our plan going forward, obviously, we see some improvement overall. But we are assuming we're going to continue to be prudent and maintain that conversion ratio at those levels. As we think about cohort of new partners that were added in '23 and 2024, they will obviously continue to add to the application flow, but we don't expect meaningful contribution from net volume perspective into the plan.

I just want to double down on that and add a little bit more color. The way we should think about it is, Pagaya has two types of businesses, right? The one business which is the main business, the fee-generating business that used to grow as we add partners. And that's why we are giving so much clarity on the application. That has all the metrics of over the cycle growing type of a business. And you should expect, again, given the quarter here and quarter there, that over the years that should go higher and higher, both in the quality of applications and sometimes it's less ability that’s easy to just demonstrate and in the total quantum of it. Now to the other side, which is the so called capital basis that in sometimes, we need to do more or less is really kind of like the thing you should think about the conversion rate that we're trying to be as prudent as possible, to balance in between the needs of all of them to the cooperate to our partners. So that is a little bit more cyclical, if you will, discussion, but the network, both fees and the application is really what we're driving towards. And where we believe there is a very different business model in Pagaya versus any other companies in this space there.

Okay. Well, thank you. I just want to ask one follow-up. Well, let's just say like, you know, I imagine, you know, with U.S. Bank you're making more conforming loans are under 36%. Is that right? Personal loans?

All of our loans are below.

Absolutely. So with, you know, maybe the risk free rate and risk premiums being elevated in this current environment, if those were to back off, so many more loans can be made at 36%. So I'm just trying to figure out, what are some of the macro forces factors that have impacted the ability to even make loans in this environment? And that's kind of my question. Is it easy? The financial conditions actually makes more loans approvable, and that's kind of where I'm going at it. I just want to have.

Your own point, there is one person -- that one person every one or two months says what he thinks about the world and how he's going to tapper in or tapper out the interest rate. And that person is influencing how ability to approve different loans. The 36% is one of the reasons. There are few others, which is meeting investor threshold, retails, et cetera. But yes, you are absolutely right that given we are going to go out of that super restrictive environment, there is definitely better ability to provide more loans to more people.

Yes. Thank you.

There are no further questions at this time. I would like to turn the floor back over to Gal Krubiner for closing remarks. Please go ahead.

Thank you, Irene. So Pagaya is in a very strong position, as all of you have heard, to continue and execute on our mission to deliver more financial opportunity to more people, more often. We have scaled our flagship credit product to almost 30 lenders, including transformational enterprise level lenders, increased our funding base to over a hundred institutional investment firms and delivered a record financial performance. We will capitalize on this momentum as we execute in 2024 and enter the new phase of our journey to become a more product and partner centric company with the leadership of Sanjiv and EP. Thank you for your time today and your continued partnership and support in Pagaya. Have a great day.

Ladies and gentlemen, this concludes today's conference. Thank you for joining us. You may now disconnect your lines.